Millions of Americans could be losing their retirement savings by not taking advantage of the simple power of compound interest, experts warn.
Being on the right side of this phenomenon will help you build wealth, but the key is to start taking advantage of it as soon as possible, said financial planner Georgia Lord.
Simply put, compound interest is interest earned on interest.
For example, if you invest $100 and earn 5 percent interest each year, you will have $105 at the end of the first year. This larger sum will earn 5 percent interest, bringing your total to $110.25 at the end of the second year.
As the years go by, this will continue to increase and grow at an ever-increasing rate as you earn interest on an ever-increasing account balance, and may even reach a million by the time you reach retirement.
Being on the right side of compound interest will help you build wealth, but the key is to start taking advantage of it as soon as possible, said financial planner Georgia Lord.
Lord, a financial planner at Corbett Road Wealth Management, says the key to making the most of compound interest is to start early, regardless of how much money you have saved.
“It’s never too late, but it’s also never too little,” he told DailyMail.com.
‘The biggest problem when it comes to capitalizing and understanding everything is the idea that people think they don’t have enough money to get started or enough to invest.
‘It’s something I see with many of my younger clients, but also with my friends and colleagues. People think they need $10,000, $50,000, or $100,000 before they can start investing.
‘Even if you start with $100, you’re getting used to saving and investing.
‘Don’t fall into the trap of saying, “I’ll do it once I save $10,000.” Get him into the habit as soon as he can. You can only benefit.’
For example, imagine you invest a lump sum of $100 at an interest rate of 7 percent.
Every month you invest another $300. Over 45 years, you’ll reap the benefits of compounding to end up with retirement savings of more than $1 million.
However, in the first 20 years it will only grow to $147,970.74.
This is because the math of compounding works better the more time you spend on it.
If you invest a lump sum of $100 at a 7 percent interest rate and add $300 each month, you will have more than $1 million after 45 years (Source: Bank Rate Calculator)
“Capitalization goes hand-in-hand with long-term investment and results,” Lord said.
‘It’s almost like a snowball going up a hill. It starts out small but little by little it gets bigger and bigger.’
But, he noted, while making recurring contributions will make your money grow faster, the act of compounding doesn’t depend on it.
She recommends using a compound interest calculator, like the one provided Bank feeto calculate how much you could save for retirement.
“People think it’s too good to be true,” he said. “But it’s important that people understand it, because then they can play with the numbers.”
You can also work backwards, Lord said, by putting a number on how much you want to save by a certain age.
Then, you can calculate how much you would need to save per month or per year to achieve that goal with the help of compounding.
Some experts recommend that Americans invest in a mutual fund or exchange-traded fund (ETF) that tracks the S&P 500.
This index of the 500 largest US companies has historically returned between 9 and 10 percent annually on average.
“One of the best decisions people can make is to start with an index fund that tracks the S&P 500 because it works,” said Todd Rosenbluth, head of research at financial consulting firm VettaFi. CNBC.
But Peter Gallagher, CEO of the Unified Retirement Planning Group, urges Americans to be cautious.
Peter Gallagher, CEO of Unified Retirement Planning Group, Urges Americans to Diversify Their Investments
“My advice is to have a plan and stick to it,” Gallagher told DailyMail.com. ‘Based on the rebound recorded so far in 2024, it could be a very volatile year, as it is an election year.
“When the market goes down, and it will, having a plan makes it a little easier because you have to have a long-term time frame and the assets have to be diversified to hold up.”
Bonds are traditionally considered a safer option for long-term investing, but Gallagher adds that there are more than 100 different asset classes to choose from.
Lord added: ‘Although the S&P 500 returns decent returns on average, it is not the only investment option when it comes to capitalization.
“If you invested in a particular tech stock that was doing well and kept pumping money into it every month, you would still see the effects of compounding.”
It comes after experts revealed how much workers in each age group would need to save in their 401(K) to reach $1 million when they retire.
According to the personal finance site The Motley FoolA 22-year-old would need to save $325 per month throughout his career to be able to retire with $1.01 million when he reaches age 62.
If a worker just started saving in their 401(K) at age 27, they would need to save $500 per month to reach $1.03 million at the same age.
The figure rises to $750, $1,200 and $1,900 for a person aged 32, 37 and 42 respectively.
The analysis assumes that the investments generate an average annual return of 8 percent, slightly below the average rate of return of 10 percent generated in the stock market.
It comes after experts broke down the amount you need to save each month to build a comfortable nest egg, depending on the age you start.
The number of savers with $1 million in their retirement accounts also skyrocketed by about 100,000 people in 2023, thanks to a booming stock market.
Some 349,000 401(K) plan owners and 339,000 workers with Individual Retirement Accounts (IRAs) ended the year with seven-figure balances, according to Loyalty investments.
Caroline Eby told DailyMail.com how she is getting closer to the million dollar mark by starting early, even though she has never won more than $80,000 in her life.
The finance worker, from Washington DC, said: ‘I started saving at age 25, when I was earning $22,000 a year in manufacturing.
Caroline Eby, 57, pictured, told DailyMail.com that she is approaching the million dollar mark, even though she has never earned more than $80,000 in her life.
‘Every year, I increased my contribution by 2 per cent if I could afford it. I maximized my contribution to around 12 per cent.’
And he added: ‘I have never been married and I have always fully supported myself. I am very happy and proud of myself for the sacrifices I made 30 years ago.
“As everyone told me, the race is won slowly and steadily.”
It comes after experts revealed how much workers in each age group would need to save in their 401(K) to reach $1 million when they retire.